Proctor and Gamble 2005 Annual Report Download - page 38

Management’s฀Discussion฀and฀AnalysisThe฀Procter฀&฀Gamble฀Company฀and฀Subsidiaries
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partially฀offset฀by฀higher฀interest฀charges฀associated฀with฀Wella,฀hedging฀
impacts฀and฀current฀year฀charges฀for฀projects฀to฀maintain฀a฀competitive฀฀
cost฀structure.฀
Financial฀Condition฀
We฀believe฀our฀financial฀condition฀continues฀to฀be฀of฀high฀quality,฀as฀
evidenced฀by฀our฀ability฀to฀generate฀substantial฀cash฀from฀operations฀
and฀ready฀access฀to฀capital฀markets฀at฀competitive฀rates.฀
Operating฀cash฀flow฀provides฀the฀primary฀source฀of฀funds฀to฀finance฀
operating฀needs฀and฀capital฀expenditures.฀Excess฀operating฀cash฀is฀used฀
first฀to฀fund฀shareholder฀dividends.฀Other฀discretionary฀uses฀include฀share฀
repurchases฀and฀“tack-on”฀acquisitions฀to฀complement฀our฀portfolio฀of฀
brands฀and฀geographies.฀As฀necessary,฀we฀may฀supplement฀operating฀
cash฀flow฀with฀debt฀to฀fund฀these฀activities.฀The฀overall฀cash฀position฀
of฀the฀Company฀reflects฀our฀strong฀business฀results฀and฀a฀global฀cash฀
management฀strategy฀that฀takes฀into฀account฀liquidity฀management,฀
economic฀factors฀and฀tax฀considerations.฀
Operating฀Activities฀
In฀2005,฀operating฀cash฀flow฀was฀$8.72฀billion฀compared฀to฀$9.36฀฀
billion฀in฀2004.฀The฀benefit฀of฀higher฀net฀earnings฀in฀the฀current฀year฀
was฀more฀than฀offset฀by฀changes฀in฀working฀capital.฀We฀define฀working฀฀
capital฀as฀the฀combination฀of฀inventory,฀accounts฀receivable฀and฀฀
accounts฀payable.฀Total฀inventory฀days฀on฀hand฀increased฀by฀two฀days฀
in฀2005฀reflecting฀the฀impacts฀of฀higher฀commodity฀costs฀and฀the฀
Company’s฀efforts฀to฀rebuild฀inventory฀levels฀in฀product฀categories฀that฀
could฀not฀sufficiently฀meet฀customer฀demand.฀Receivable฀days฀sales฀
outstanding฀improved฀by฀two฀days,฀resulting฀in฀a฀slight฀improvement฀to฀
operating฀cash฀flow.฀Accounts฀payable฀decreased฀three฀days.฀In฀addition฀
to฀the฀increase฀in฀working฀capital,฀operating฀cash฀was฀reduced฀by฀tax฀
payments฀related฀to฀the฀settlement฀of฀prior฀year฀audits.
In฀2004,฀operating฀cash฀flow฀was฀$9.36฀billion฀compared฀to฀$8.70฀฀
billion฀in฀2003,฀representing฀an฀increase฀of฀8%.฀Higher฀net฀earnings฀
were฀the฀primary฀driver฀of฀the฀increase฀in฀operating฀cash฀flow.฀Operating฀
cash฀flow฀growth฀trailed฀earnings฀growth฀due฀to฀an฀increase฀in฀accounts฀
receivable,฀cash฀payments฀for฀accrued฀restructuring฀program฀charges฀
and฀a฀dividend฀received฀from฀a฀joint฀venture฀in฀2003.
We฀view฀free฀cash฀flow฀as฀an฀important฀measure฀because฀it฀is฀one฀฀
factor฀impacting฀the฀amount฀of฀cash฀available฀for฀dividends฀and฀฀
discretionary฀investment.฀It฀is฀defined฀as฀operating฀cash฀flow฀less฀
capital฀expenditures฀and฀is฀one฀of฀the฀measures฀used฀to฀evaluate฀฀
senior฀management฀and฀determine฀their฀at-risk฀compensation.฀In฀2005,฀
free฀cash฀flow฀was฀$6.54฀billion฀compared฀to฀$7.34฀billion฀in฀2004.฀฀
In฀addition฀to฀lower฀operating฀cash฀flow,฀free฀cash฀flow฀declined฀฀
year-over-year฀due฀to฀higher฀capital฀expenditures.฀Capital฀expenditures฀
in฀2005฀were฀higher฀than฀in฀2004,฀but฀still฀below฀our฀target฀of฀capital฀
spending฀at฀or฀below฀4%฀of฀net฀sales.฀
In฀2004,฀free฀cash฀flow฀was฀$7.34฀billion฀compared฀to฀$7.22฀billion฀
in฀2003.฀Free฀cash฀flow฀in฀2004฀reflected฀increased฀operating฀cash฀
flow,฀partially฀offset฀by฀increased฀capital฀expenditures,฀although฀spending฀฀
was฀in-line฀with฀our฀target฀of฀capital฀spending฀at฀or฀below฀4%฀of฀sales.฀
Capital฀spending฀in฀2003฀was฀well฀below฀historical฀levels฀and฀the฀฀
Company's฀target.
Free฀cash฀flow฀productivity,฀defined฀as฀the฀ratio฀of฀free฀cash฀flow฀to฀
net฀earnings,฀was฀90%฀in฀2005,฀in-line฀with฀the฀Company’s฀target.฀Free฀
cash฀flow฀productivity฀was฀113%฀in฀2004.
Investing฀Activities
Investing฀activities฀in฀the฀current฀year฀used฀$2.34฀billion฀of฀cash฀฀
compared฀to฀$10.14฀billion฀in฀the฀prior฀year,฀which฀included฀the฀฀
cash฀used฀for฀the฀acquisition฀of฀Wella.฀
Acquisitions.฀Acquisitions฀(net฀of฀cash฀acquired)฀used฀$572฀million฀of฀
cash฀in฀the฀current฀year฀which฀includes฀acquisitions฀of฀a฀Pharmaceuticals฀
business฀in฀Spain,฀Fabric฀Care฀businesses฀in฀Europe฀and฀Latin฀America฀
and฀increased฀ownership฀in฀our฀Glad฀venture฀with฀The฀Clorox฀Company.฀
In฀2004,฀net฀cash฀used฀for฀acquisitions฀was฀$7.48฀billion,฀driven฀by฀the฀
acquisition฀of฀Wella฀and฀the฀purchase฀of฀the฀remaining฀stake฀in฀our฀China฀฀
venture฀ from฀Hutchison฀Whampoa฀ China฀ Ltd.฀(Hutchison).฀The฀฀
initial฀Wella฀acquisition฀in฀September฀2003฀was฀approximately฀$5.10฀฀
billion฀for฀an฀81%฀interest,฀funded฀by฀a฀combination฀of฀debt฀and฀cash.฀
In฀June฀2004,฀the฀Company฀and฀Wella฀completed฀a฀Domination฀and฀
Profit฀Transfer฀Agreement,฀which฀provided฀us฀full฀operating฀control฀and฀
rights฀to฀100%฀of฀future฀operating฀results.฀In฀exchange,฀we฀must฀pay฀
the฀remaining฀Wella฀shareholders฀a฀guaranteed฀annual฀dividend฀payment.฀฀
Alternatively,฀the฀Wella฀shareholders฀may฀elect฀to฀tender฀the฀shares฀
for฀a฀fixed฀price.฀The฀obligation฀associated฀with฀the฀Domination฀and฀฀
Free Cash Flow and Free Cash Flow Productivity
(in billions of dollars, and as % of net earnings)
2002 20052003 20042001
0%
160%
120%
80%
40%
0
$8
4
2
6
Free Cash Flow
Free Cash Flow Productivity
Free Cash Flow Productivity Target